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Macau’s continued weak gaming revenues plus sizeable Capital Investment triggers a change in our recommendation for Crown Subordinated Notes

After a 39.4% decline in gaming revenue for the month of March and a 35% fall over the first 3 months of the year, the Gaming Inspection and Coordination Bureau of Macau reported a 38.8% year on year decline in gross gaming revenue in April, the 11th consecutive monthly decline. In the first 4 months of 2015, Macau’s gross gaming revenue fell 37.1% year on year.

Macau’s overall gaming revenue decline over the past 3 months is the most severe since the special administrative region liberalized its gaming sector in early 2000. This is largely due to the material decline in VIP gaming revenue, which plummeted by 42% year on year in the first quarter of 2015, as the Chinese government continues its efforts to combat corruption and slower GDP growth.

Melco Crown Entertainment (MCE) is the joint venture between Crown Resorts and Melco, in which Crown owns 34.3% as at January 2015. MCE’s contribution to reported net profit was $85.3m from $262.4m for the whole group (ie 32.5%) and was down 42.2% compared to the previous year. The decline in Macau gaming revenue will impact negatively MCE Finance Limited, Melco Crown (Macau) Limited and Studio City Finance Limited, all affiliates and subsidiaries of MCE and will weaken their overall revenue and EBITDA generation. Notwithstanding MCE strong financial profile, the weaker operating environment “will make it more challenging for Studio City Finance to ramp up its Studio City Project so that it opens in the second half of the year and realizes planned revenue growth and deleveraging in the next one to two years” according to Moody’s. This is slightly mitigated by Studio City Project cinematically themed and as such less-gaming related.

In an overall environment, where economic growth in Australia is not growing as fast as before as it experiences the fall in commodity and erngy prices, Crown Resorts despite its relatively strong credit profile is experiencing a bit of a triple whammy:

  1. Crown Melbourne and Perth, being its “crown jewels” will surely experience a slowdown in attendance due to tougher economic conditions both in Australia and in China, where  the majority of tourists originate from;
  2. CWN needs to finance some significant investments (new Five Star Hotel in Melbourne, the Crown Towers in Perth, the Crown Sydney in Barangaroo, the Queen’s wharf Brisbane Proposal); and
  3. The joint venture with Melco is experiencing tough conditions, so it will delay any expected contributions in earnings and dividends.

Given all these above mentioned risks, we feel we need to change our recommendation on the Crown Subordinated Notes (CWNHA) and the Subordinated Notes II (CWNHB) to SELL. Investors are definitely not compensated for the tough year ahead, and we would wait for better entry points.